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The deepening chaos in Europe’s energy markets risks undermining the region’s recovery and complicating policy for officials desperately trying to put the worst economic crisis in a generation behind them.
Power and gas prices have rocketed in financial markets over the past few weeks as traders grapple with a shortage of supply for the coming winter. Many short-term prices are trading at multiples of their usual ranges and even longer-term markets for 2022 are sharply higher. While there’s a lag before the full impact hits households and consumers, politicians are already fretting about the effect on voters.
Millions of U.K. consumers will see power bills rise more than 10% in October and the government is being pressed to bail out struggling suppliers. In Spain, where power prices are in uncharted territory, the government has cut taxes on energy and proposed capping profits at utilities. And in Italy, Prime Minster Mario Draghi -- once Europe’s top central banker -- is ready to spend 3.5 billion euros ($4.1 billion) of public funds to reduce the impact on households. But prices keep heading higher and the weather is about to get colder and darker.
“There is a huge consumer tax right now being implemented and it’s going to get higher during the winter, “ said Steen Jakobsen, chief economist at Saxo Bank A/S. “Anyone who thinks this is temporary is out for a big shock during the winter.”
The mix of ultra-loose monetary policy, supply chain frictions and rising commodity prices has seen inflation perk up across Europe.
Euro-area consumer prices rose 3% in August, the highest in a decade. In the U.K., inflation surged more than expected to the strongest pace in more than nine years. The price of raw materials entering factories surged 11% from a year ago in August.
Among central bankers, however, the consensus remains that the increase in consumer prices is temporary.
European Central Bank President Christine Lagarde said on Sept. 9 that the “temporary upswing in inflation mainly reflects the strong increase in oil prices,” among other factors. They should fade out in 2022, in the year-on-year comparison. Eurozone inflation remains well below the U.S., where prices rises are faster than any major economy.
Still, the bank’s vice-president, Luis de Guindos, said on Sept. 17 the upswing may be more pronounced than originally anticipated. “Inflation this year may turn out even higher than we now think if the supply problems persist,” he said.
While electricity, gas and heat energy constitute just under 6% of the euro-area’s consumer price basket in 2021, the danger for Largarde and other central bankers is that the impact of surging energy costs ripples through the economy, spreading the price impact to other industries and ultimately wages.
That’s starting to happen. Some of Europe’s largest fertilizer plants have shut down, sending prices soaring -- a cost farmers may have to pass on to customers.
Food-processing is also very energy intensive, creating another possible pressure points for higher power and gas costs to leak into consumer prices.
“It creates an inflationary pressure on every other cost,” said Pascal Leroy, a senior vice-president at Roquette Freres SAS, a French food processing company. “We will have to be passing on those costs to our consumers.”
Other industries where energy makes up a big chunk of costs and could inject severe price pressure into the supply chain include cement, ceramics, glass and paper.
To be sure, many businesses will be hedged against recent power and gas increases, at least in the short term.
“Although it is likely that many have hedges in place to smooth out short-term fluctuations in costs, thus making their businesses and the prices they charge customers more manageable, the longer prices stay high, the more impact will be felt as hedges will start to roll off,” Barclays strategist Emmanuel Cau said in a note to clients.
The longer the rally goes on -- and gas traders predict a cold winter could see prices reach stratospheric levels -- the bigger the impact on consumers and businesses. Higher energy costs may even hold back economic recovery, heralding the return of 1970s style “stagflation,” where prices rise faster the economic growth. Politicians may need to consider more radical actions to stop that happening.
“If the gas prices continue to rise, which is going to create inflationary pressures in continental Europe and in the U.K, and start curbing recovery, you might actually see some drastic measures taken in Europe,” said Ogan Kose, a managing director at consultant Accenture. “There might be drastic decisions associated with subsidizing the retail energy prices, electricity prices, commercial and industrial gas prices.”
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